30 Jan Will California Municipalities Have to Obtain State Clearance Before Filing Chapter 9?

One of the most deeply rooted concepts in American bankruptcy jurisprudence is the idea that, with few exceptions, virtually any private debtor may seek relief under the US Bankruptcy Code.

Where the debtor is a public entity, however, such relief is not guaranteed. Instead, municipalities seeking readjustment of their debt must be authorized to do so. Such authorization is typically provided by state statute.

In California, Government Code section 53760 gives “local public entities” the power to “file a petition and exercise powers pursuant to applicable federal bankruptcy law.” To do so, however, these “local public entities” must meet the Bankruptcy Code’s tests for entry into Chapter 9 – the Code Chapter designed to afford “debt readjustment” relief for municipalities. Specifically, such “local public entities” must be insolvent (i.e., not paying or unable to pay their debts when due) – a status which may be contested before the debtor enters Chapter 9. They must also propose a debt readjustment plan (as opposed to a plan of liquidation). Finally, to obtain Chapter 9 relief, they must:

– have obtained the agreement of creditors holding at least a majority in amount of the claims of each class; or

– have negotiated in good faith with such creditors and failed to reach agreement with a majority in amount of the claims of each class; or

– be unable to negotiate with creditors because such negotiation is impracticable; or

– reasonably believe that a creditor may attempt to obtain a preferential transfer, to the detriment of other creditors.

It may sound like an awful lot. But the fiscal impact of the global economic crisis – and of Sacramento’s fiscal crisis – on municipal budgets throughout California has sent local governments scrambling to review these provisions in earnest.

This week, the California legislature was introduced to what may yet become another barrier to Chapter 9 entry. The Solano County Times-Herald reported yestereday that State Sen. Pat Wiggins and Democratic Assemblyman Tony Mendoza (whose district includes Los Angeles and Orange counties) have co-authored new legislation that would make it harder for California municipalities to obtain Chapter 9 bankruptcy protection. According to staff writer Jessica York, the proposed legislation – Assembly Bill 155 – would require a municipality to receive filing approval from a 3-person state panel prior to commencing a Chapter 9 proceeding.

The bill is borne of concerns over the effects a Chapter 9 filing can have on local taxpayers and on a bankrupt municipality’s credit-worthiness in the bond markets. It is further prompted by a perceived need for state legislators to involve themselves with local deficits.

But not everyone welcomes that involvement. As Ms. York reports:

League of California Cities leaders have some concerns with the bill, including who is sponsoring the legislation and motives behind the bill, said spokeswoman Megan Taylor. She added that state leaders could do more good by resolving the state budget standoff, thereby providing economic certainty for cities and avoiding a bankruptcy avalanche. “If the state is concerned with having local agencies getting to the point of bankruptcy, the most important thing that they can do is balance the state budget,” Taylor said. Marc Levinson, [City of] Vallejo’s [Chapter 9] bankruptcy attorney, said he believed the bill was a bad idea at first glance. The state-appointed committee would likely have partisan political pressures weighing into their decisions, he said. “They’re going to have to spend a lot of time just getting up to speed . . . .”

Will “local public entities” in California now have to get the state’s permission to commence a Chapter 9?